Question 19.A.3: Sustainable Growth and Financial Statements PROBLEM: Becaus...
Sustainable Growth and Financial Statements
PROBLEM: Because of your presentation (see Decision-Making Example 19.2), Empire’s top management team has had second thoughts about their goal of growing the firm 20 percent during the next year. As a result, they have asked that you prepare pro forma financial statements at a sales growth rate equal to the firm’s SGR of 13.3 percent.
APPROACH: For the income statement, all costs grow at the same rate as revenues. Thus, you can multiply the current period’s sales and costs by 1.133 to calculate the projected values of sales and costs. To construct the balance sheet, you must first compute the values of accounts that vary with sales. Since you have no information about how much of Empire’s total debt is long-term debt, you should enter its total debt value of $20 million, along with all the information you have on the balance sheet accounts. Finally, to make the balance sheet balance, you should calculate the amount of EFN.
Sales = $100 million × 1.133 = $113.30 million
Costs = $90 million × 1.133 = $101.97 million
Income statement:
Dividend = Net income × Payout ratio = $11.33 million × 0.60 = $6.80 million
\begin{matrix} Addition \ to \ retained \ earnings &=& Net \ income \times Plowback \ ratio= \$11.33 \ million \times 0.4 \\ &=&\$ 4.53 \ million \end{matrix}Forecast value of the assets: $50 million × 1.133 = $56.65 million
Value of the equity: $30 million + $4.53 million = $34.53 million, where $30 million is the initial value and $4.53 million is the addition to retained earnings Value of debt plus equity: $20 million + 34.53 million = $54.53 million
The balance sheet does not balance ($56.65 million assets > $54.53 million debt plus equity), and the difference ($2.12 million) is the plug number, which is the EFN. Thus, to achieve the 13.3 percent rate of growth, Empire will need to issue $2.12 million in long-term debt, which will bring the debt account to $20 million + $2.12 million = $22.12 million. The resulting balance sheet is as follows:
| Empire Enterprises Pro Forma Balance Sheet ($ millions) |
|||
| Assets | Liabilities and Stockholders’ Equity | ||
| Assets | \underline{\$56.65} | Debt | $22.12 |
| Equity | \underline{34.53} | ||
| Total assets | 56.65 | Total liabilities and stockholders’ equity | $56.65 |